10. Utility, Indifference curve and Budget line.ppt

INDIFFERENCE
CURVE
AND
BUDGET LINE

Approaches to Consumer Behaviour
• Propounded by
Marshall
• Known as Marshalling
Approach
Cardinal
Utility
Approach
• Propounded by Hicks
& Allen
• Known as Indifference
Curve Analysis
Ordinal
Utility
Approach
2

Utility
3
 Utility is synonymous with
“Pleasure”, “Satisfaction” & a Sense
of Fulfillment of Desire.
 Utility → “WANT SATISFYING
POWER” of a Commodity.
 Utility is a psychological phenomena

-Mrs. Robinso4n
Utility
• Utility refers to Abstract Quality whereby an
Object Serves our Purpose.
- Jevons
• Utility is the Quality of a Good to Satisfy a
Want.
-Hibdon
• Utility is the Quality in Commodities that
makes Individuals want to buy them.

5
Features of Utility
• Utility is Subjective
It deals with the Mental Satisfaction of a Man.
For Example, Liquor has Utility for a Drunkard but for a
Teetotaler, it has no Utility.
• Utility is Relative
– Utility of a Commodity never remains same. It varies
with Time, Place & Person. For example, Cooler has
utility in Summer but not during Winter.

6
• Utility is Not Essentially Useful
– A Commodity having Utility need not be Useful.
E.g., Liquor is not useful, but it Satisfies the Want
of an Addict thus have Utility for Him.
• Utility is Ethically Neutral
– Utility has nothing to do with Ethics. Use of
Liquor may not be good from the Moral Point of
View, but as these Intoxicants Satisfy wants of the
Drunkards, they have utility.
Features of Utility

Concepts of Utility
• The Utility Derived from the
Consumption of 1st Unit
of Commodity.
Total Utility
• Change in Total Utility resulting
from the change in
Consumption.
• MU = TUn+TUn-1
Marginal Utility
Initial Utility
7
• The Aggregate of Utilities
obtained from the Consumption of
Different Units of Commodity.
• TUn= U1+U2+U3+U4+…..+Un

mer
Types of Marginal Utility
• With Consumption of an
Additional Unit of a Commodity,
Total Utility Increases.
Positive
Marginal
Utility
• With Consumption of an
Additional Unit of a
Commodity, Total Utility
Remains Same.
Zero Marginal
Utility
• With Consumption of an Additional
Unit of a Commodity, Total Utility
decrease
Negative
Marginal
Utility 8

- Samuelson
13
Laws of Diminishing Marginal Utility
• The Additional Benefit which a Person
derives from a given Increase in Stock of
a thing Diminishes with Every Increase in
the Stock that he already has.
-Marshall
• As the Amount Consumed of a Good
Increases, the Marginal Utility of the
Good tends to Decrease.

10
Assumptions to Law of Diminishing
Marginal Utility
Other things being equal
- Utility can be Measured in the Cardinal Number
System.
- Marginal Utility of Money remains Constant.
- Marginal Utility of Every Commodity is
Independent.
- Every Unit of the Commodity being used is of
same Quality & Size.

11
Assumptions of Law of Diminishing
Marginal Utility
• There is a Continuous Consumption of the
Commodity.
• Suitable Quantity of the Commodity is
Consumed.
• There is No Change in the Income,
Tastes, Character, Fashion and Habits
of the Consumer.
•There is No Change in the Price of the
Commodity and its Substitutes.

General Economics: Theory of Consumer Behaviou-
Indiffernce Curve
16
Explanation
Quantities of Tea
Consumed
(cups per day)
Total Utility Marginal Utility
1 30 30
2 50 20
3 65 15
4 75 10
5 83 8
6 89 6
7 93 4
8 96 3
9 98 2
10 99 1
11 95 -4

Explanation
35
30
25
20
15
10
5
0
-5
-10
17
0 2 4 6 8 10
Quantity of Tea (Cups per Day)
12
Index
of
Utility

18
Limitations of the Law
o Utility considered as Cardinally measureable Untenable
as Utility is a Subjective Concept.
o Unrealistic Assumption regarding Marginal utility of
money being constant. Money is subject to change.
o No Empirical Verification.
o The Derivation of Law is based on assumption of
Ceteris Paribus which is unrealistic

Indifference Curve
• A Single Indifference Curve shows the different
Combinations of X and Y that yield Equal
Satisfaction to the Consumer.
- Leftwitch
• An Indifference Curve is a Combination of Goods,
each of which yield the same level of total utility
to which the consumer is indifferent.
- Ferguso2n
5

26
Assumptions to Indifference
Curve Analysis
1. Rationality of Consumer
The Consumer is Rational & aims at maximizing his
Total Satisfaction.
2. Ordinal Utility
Utility can be expressed Ordinally i.e. Consumer is
able to tell only Order of his Preferences.
3. Non-satiety
Consumer is not Oversupplied with goods in
Questions.

27
Assumptions to Indifference
Curve Analysis
4. Transitivity of Choice
Means that if a Consumer prefers A to B & B to C,
he must prefer A to C.
5. Consistency of Choice
Means that if a Consumer prefers A to B in one
period, he will not prefer B to A in another
period or Treat them as Equal.

Indifference Curve Schedule
• An Curve Indifference Schedule refers to a
Schedule that Indicates different Combinations of
Two Commodities which yield Equal Satisfaction.
Combination of apples
and oranges
Apples Oranges
A 1 + 10
B 2 + 7
C 3 + 5
D 4 + 4
28

29
Indifference Curve
•Indifference Curve is a Diagrammatic
representation of indifference
schedule
• IC is an Indifference curve.
• It is a line that shows all possible
Combinations of Two Goods
between which a person is indifferent
Apples
1 2 3 4 5 6
IC
IC
A ( 1 + 10)
B ( 2 + 7 )
C ( 3 + 5 )
D (4 + 4 )
Y
10
7
5
4
0
Oranges

Satisfaction
30
Indifference Map
• An Indifference Map
represents a Group of
Indifference Curves
which
each of
expresses a given level
of Satisfaction.
•If an Indifference curve
Shifts
Level
to Right, the
of Satisfaction
goes on Increasing.
• From the Point of View
of
IC >IC >IC
2 1
IC1
IC2
IC3
Good
Y
Good X

31
Marginal Rate of Substitution (MRS)
• The Rate at which an Individual must give up
“Good A” in order to obtain One More Unit of “Good
B”, while keeping their Overall Utility
(Satisfaction) Constant. The MRS is Calculated
between Two Goods placed on an Indifference
Curve, which displays a Frontier of Equal Utility for
Each Combination of “Good A” and “Good B”.
• MRS Keeps on Declining since Consumer has
more & more units of one Good, he gives up
Less Units of Other Good.

Properties of Indifference Curve
22
• An Indifference Curve has a Negative Slope i.e.
it Slopes Downwards.
• Indifference Curves are always Convex to the
Origin.
• Two Indifference Curves never Intersect or
become Tangent to Each other.
• Higher Indifference Curve represents Higher
Satisfaction.

23
• An Indifference Curve has a Negative
Slope i.e. it Slopes Downwards.
–This Property Implies that when the
Good in Combination is
amount of one
Increased, the amount of the Other Good is
reduced. This is Essential if the Level of
Satisfaction is to remain the same on
an Indifference Curve.

24
• Indifference Curves are always Convex to
the Origin.
– This implies that the Two Commodities are
Imperfect Substitutes for each other & that
the MRS between the two Goods Decreases
as a Consumer moves along an Indifference
Curve.

35
• Indifference Curves are always Convex to
the Origin.
– Two Extreme conditions also exists.
• When 2 Goods are Perfect Substitutes,
Indifference Curve will be a Straight Line on
which MRS is Constant.
• When 2 Goods are Complementary,
Indifference Curve will consist of 2 Straight
Lines with a Right Angle bent which is convex
to the origin i.e. it will be L shaped.

36
• Two Indifference Curves never Intersect
or become Tangent to Each other.
– If Two Indifference Curves Intersect or are
Tangent, it would imply that an Indifference
Curve indicates Two different Levels of
Satisfaction (One Being Larger than the
Other) yield the Same Level of Satisfaction.
This will Violate the Rule of Transitivity.

• Two Indifference Curves never Intersect
or become Tangent to Each other.
IC1
IC2
Good
Y
• A
Good X 37
• C
• B

28
• Higher Indifference Curve represents
Higher Satisfaction
–This is because the Combinations lying in
Higher Indifference Curve Contain
More of either one or Both Goods and
More Goods are preferred to Less of
them.

Price Line or Budget Line
29
• The Budget Line shows all those
Combinations of Two Goods which
the Consumer can buy Spending his
Given Money Income on two Goods
at their given Prices.
•Remember, that the Amount of a Good
that a Person can buy will depend upon
their Income and the Price of the Good.

Price Line or Budget Line
• Point outside the
given Price Line,
like H, will be Beyond
the Reach of
the Consumer.
• Point Below the
given Price Line,
Like K, shows the
Under Spending of
the Consumer.
Y
40
X
O
•H
•K
Good
Y
Good X
PRICE LINE
M
N

41
Consumer Equilibrium
• Consumer Equilibrium will be reached
when he is deriving Maximum possible
Satisfaction from the Goods & is in no
Position to Rearrange his Purchase of Goods.
• The Indifference Map in Combination with the
Budget Line allows us to Determine the
One Combination of Goods and Services
that the Consumer most wants and is able to
Purchase. This is the Consumer Equilibrium.

• PL – Budget Line
• Points R, S, Q, T,
H all lie on
Budget Line But Q
is Equilibrium
Point.
IC2
IC1
IC3
IC4
Good
Y
M
Good X
Y
P
N
O
R
Q
H
L
S
42
T
X

• At the Tangency Point Q, the slopes of the
Price Line PL And Indifference Curve IC3 are
equal.
• Slope of Indifference Curve shows MRS of X for
Y (MRSxy)
• At Equilibrium Point Q,
33
=
MUX PX
XY
MUY PY
MRS 

10. Utility, Indifference curve and Budget line.ppt

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